Author: Thu Tran
I am a single mom, and like most single parents, I find myself having to juggle a lot of different responsibilities – especially when it comes to finances and saving for the future. Between trying to make ends meet living in Hawaii, financing my daughter’s college education, and planning for my retirement, I often think, “where do I even begin?”
College tuition—including other costs like fees, books, and housing—continues to rise every year. My daughter is 11 years old, which means that I only have about seven years left to save for her education and that I have to be smart and economical about how I get there. It’s never too early to start saving! In fact, some parents even start right after the birth of their child. You’d be surprised how much difference a few extra years can make when it comes to savings plans.
So, what’s the best way to save for your kid’s education without completely wiping out for your savings plans? I have highlighted three of the most popular means of planning for college: a 529 plan, Roth IRA, and a permanent life insurance plan. Let’s take a closer look at each.
529 accounts, legally known as “qualified tuition plans,” are tax-advantaged and sponsored by states, state agencies, or educational institutions and can only be used to pay future college expenses.
There are two types of 529 plans: prepaid tuition plans and education savings plans. The more common of the two is the savings plan, which can be used for tuition, fees, books, supplies, equipment, computers, and room and board. A 529 plan grows your money by selection of specific investment tools like mutual funds or automated portfolios of investments which are chosen with the help of an investment advisor. As of 2018, the IRS now allows up to a $10,000 tax-free withdrawal per year, per beneficiary for expenses relating to attending private, public, and religious K-12 schools. Each state is different when it comes to a state income tax deduction and you don’t have to just use your home state’s plan. You can choose to use another state’s plan if that is a better option for you based on its specific tax advantages.
According to U.S. News, there are several misconceptions to using a 529 as a college planning tool. One is that the yearly contribution limits are the same as in an individual retirement account (IRA). Although states can set high contribution limits (as much as $380,000), you could get taxed significantly. However, federal law allows single parents to contribute only up to $15,000 annually per parent or make a lump sum contribution of $75,000 in a five-year period. Married couples can contribute up to $30,000 annually or $150,000 lump per five-year period. This can be great for grandparents to do estate planning as well.
There are some disadvantages that should be noted. One is that a 529 plan might hurt your child’s chance of getting need-based financial aid, since the value in your 529 will be included in the State Education Financial Needs Analysis. Another disadvantage would be if your child decides to attend a university outside of the U.S. In that case, the 529 wouldn’t be of any help—it can, however, be switched to another child or family member for future education needs. An important thing to note is the potential for investment/market risk when your child is almost ready to start college: since 529 is invested in the market, there is a chance for it to decline when you need the funds the most. You can talk to your advisor about putting the plan into more conservative investments as your child gets closer to college age, but as with any investment, you assume some risk for market volatility.
Another option is a Roth IRA, a special retirement account that you fund with post-tax income. However, unlike the 529, this means you can’t deduct your contributions on your income taxes. All future withdrawals from this account are tax-free if you follow the regulations and guidelines for withdrawals. The maximum yearly contribution limit is $6,000 ($7,000 if you’re over age 50) as of 2019. Both earnings on the account and withdrawals after age 59½ are tax-free, but subject to a 10 percent penalty if accessed prior to that age.
There are special rules when withdrawing funds for educational expenses since this is meant to be a retirement account. As stated above, the Roth IRA does not allow for tax-free withdrawals of earnings until the age of 59 ½; however, this is a planning tool and a retirement vehicle which may be a flexible account, where the money can be used for different permissible purposes – including college tuition. Keep in mind that much like the 529, the amount you pull from your Roth IRA for college expenses will be included in the State Education Financial Needs Analysis which could affect your child’s chances for financial aid.
Permanent Life Insurance
One savings option that has grown in popularity is a permanent life insurance policy. A permanent life insurance policy on a child goes beyond the benefit of premature death—it has many benefits, including potential funding for college. A good type of permanent life insurance is universal life, or specifically an equity indexed policy, can provide lifelong protection while building cash value tax-deferred, which can be accessed later tax-free through loans and/or withdrawals.
A simple discussion around this requires basic knowledge of the types of life insurance:
Term insurance is generally the least expensive option and is done purely for death protection benefits. Term insurance has no value accumulation and if you outlive the term of the policy, you have no refund or access to cash value.
A permanent life insurance policy, which includes whole or universal (indexed or variable), will remain in force as long as the scheduled premiums are paid.
Whole life is the more expensive option because the premiums are level over the life of the policy. The benefits, though, are that it has the potential to build tax-deferred cash value and you have access to these funds.
Universal life is also known as a “flexible premium” policy allowing you to adjust the face amount on your policy, and have a choice of two or three different premiums per month or year, so long the accumulated value in the policy is enough to cover the cost of insurance each month. What that means is that there is cash value being built without paying current income taxes on the increases, and you have the potential to access the funds tax-free using loans and withdrawal. You can always pay more premiums to build back the accumulated cash value. You also have the ability to increase or decrease your death benefit depending on your needs.
Universal life can also be broken down into two types of policies: fixed universal life and indexed universal life. The main difference between them is how the policy’s interest is credited. The interest rate is declared by the company in a fixed universal life policy; for the indexed policy, interest is based on the changes in value of a major market index like the S&P 500. Depending on your risk tolerance, both offer different degrees of guarantees and returns.
Marketwatch.com recently published the article, “How to Use Life Insurance to Pay for College,” expressing that permanent life insurance plans offered an “unconventional and yet underused” way to save for college. Since cash value is being accumulated in a permanent life insurance policy, you could potentially borrow against the cash value in your policy by taking out loans to fund your child’s education—assuming there is enough cash value in the policy to still keep the policy alive.
Be cognizant that any loans or withdrawals will reduce the cash value and death benefit, and the policy can lapse if the cash value and premiums are not enough to sustain the policy. You might need to pay additional premiums to make sure your policy remains in force. If you take loans or withdrawals in excess of the amount of premiums paid into the policy, you might also be subject to ordinary income tax. One key thing to note is that, unlike the 529 and Roth IRA, borrowing from the cash value from your life insurance plan doesn’t affect college financial aid calculations. And you can decide the amount of the policy and cash value building potential, unlike the caps put into place like a 529 Plan or Roth IRA.
My personal choice
Life insurance has changed in the last 20 years. It is no longer just about dying – it’s also about protecting you and your family if you get sick or injured. Life insurance can do several functions at one time: cash accumulation, protection against death or sickness/injury, college funding, and future retirement supplement as well. To help protect and prepare for both my daughter’s and my futures, we both have an equity indexed universal life insurance with National Life Group. The current interest rate of my cash value account in the policy is at 6.88 percent. Should I decide to take a policy loan against my cash value, the loan rate would be 4.4 percent. This means that I am still gaining interest while I loan what I need to fund my daughter’s college. We have lifelong protection as well as cash value accumulation, and I’m still gaining growth in my cash value even if I take a policy loan!
If I die too soon, my daughter will get a death benefit. The policy also protects me against chronic or critical illnesses including a stroke, heart attack, cancer, or even being disabled. If I don’t die, get seriously ill or injured, I can access the cash value later in life to fund a happy, healthy tax-free retirement. I can gift it to my daughter when she is older to help her get a head start in life for her retirement, too. Of course, the primary reason I got my life insurance was that the cash value can be accessed for college education by loans against the policy value and cash accumulated. The loan is not required to be paid back if I choose not to. Many different scenarios and “what ifs” can be explored when choosing permanent life insurance.
I’m not rich and I’m no tax expert but from my own research, this is a fantastic bundled deal to fund both my daughter’s college expenses as well as my own retirement. There are many different ways to save for college expenses and retirement, but personally I have chosen to save for my retirement and my daughter’s college by using a permanent life insurance.
To summarize, balancing saving for your child’s college and your retirement is a question many parents have to ask themselves.
A few options to look into are the 529, Roth IRA and permanent life insurance plan
The Roth IRA and permanent life insurance plan can be a way to combine your efforts when saving for retirement and your child’s college
Before making a decision review the tax advantages, or disadvantages, and how it relates to your specific situation
Thu (not one but Thu) Tran is a single mother of a precious 11-year-old daughter named Heaven. As a Financial Services professional, Thu is very passionate about helping families plan for and protect their financial futures. Four years ago, Thu gave up her life and career in Oregon to move back home to Hawaii to care for her sick father who had suffered from a heart attack, stroke and respiratory failure, which led him into a coma and later a cancer scare. While Thu was unemployed for two years and by her dad's bedside, the bills piled on. After experiencing such great financial hardship, Thu made it her mission to educate everyone about the importance of life insurance you don't have to die to use – living benefits – so that others will not have to go through what she went through. Thu also loves to help teachers, educators, and service members to help them better understand and plan for retirment. When Thu is not being a workaholic or training and mentoring her agents, she can be found hiking, at the gym, enjoying a beautiful sunset at the beach, or at the movies with Heaven. Thu is a well-rounded individual who loves learning new things and networking with new people. She loves spending time with her family and has great love for cooking, eating yummy food, playing with dogs, and enjoying music. Check her out on Instagram to learn about financial literacy, follow her latest adventures, and see what's baking.